Chapter 7:Market Structures

Chapter 7:Market Structures

7-1: Competition and Market Structures

Adam Smith (1723 – 1790)– Scottish philosopher and economist– Introduced and recognized the importance of the

concept of “division of labor”, the idea that labor becomes more productive as each worker becomes more skilled in a single job.

– Believed that competition and individual self-interest would act as an “invisible hand” to guide resources to their most productive uses.

– Laissez-faire - philosophy that government should not interfere with business activities (let it be)

Market structure – nature and degree of competition among firms in the same industry market structures video

Perfect Competition - Theoretically ideal situation that is used to evaluate other market structures perfect competition video

Necessary conditions: 1. No single buyer or seller is large enough or powerful enough to affect the price. 2. Identical products means that there is no need for

brand names or to advertise, which keeps prices low. 3. Each buyer and seller acts independently, creating

competition. 4. Buyers and sellers are well-informed about products and prices. 5. Buyers and sellers are free to enter into, conduct,

and get out of business.

Market supply and demand set the equilibrium price for the product. Profit is maximized where marginal cost = marginal revenue. maximizing profits video

Monopolistic Competition is a market structure that shares all of the conditions of perfect competition except identical products. - Products are similar, but not identical.

- Product differentiation – real or perceived differences between competing products in the same industry.

- Non-price competition – advertising, giveaways or other promotions designed to convince buyers that the product is somehow unique or better than a competitor’s. Advertising is important.

Oligopoly is a market structure where a few large sellers dominate the industry.

- Whenever one firm acts, the other firms in the industry usually follow, or they run the risk of losing customers.

- Often compete on a non-price basis by enhancing their products with new or different features.

- Collusion is a formal agreement to set specific prices, limit output, divide markets, or otherwise behave in a cooperative manner. Usually illegal because it restrains trade.

- Because of all the non-price competition, the product’s final price will be higher than it would be under monopolistic competition and much higher than under perfect competition.

Monopoly is a market structure with only one seller for a particular product monopoly video

Natural monopoly – occurs where the cost of production are minimized by having a single firm produce the product.

- Created by economies of scale, a situation in which the average cost of production falls as a firm gets larger.

Geographic monopoly – based on the absence of other sellers in a certain geographic area.

Technological Monopoly – based on ownership or control of a manufacturing method, process, or other scientific advance. (patent)

Government monopoly – monopoly owned and operated by the government

7-2: Market FailuresA market failure occurs when one or more of the conditions

necessary for competitive markets does not exist.

1. Inadequate competition – not enough sellers or buyers2. Inadequate information – not enough information available about market conditions3. Resource immobility – land, capital, labor, and entrepreneurship do not move to markets where returns are the highest 4. Public goods – products that are collectively consumed by everyone. Because it is difficult to have all individuals pay their “fair share” of a public good, private markets produce too few of them. public goods video

5. Externalities – economic side effect that affects an uninvolved third party. Considered a market failure because their costs and benefits are not reflected in the market price.

Negative externalities – harmful side effects, such as pollution or noise - can be corrected by charging a tax

Positive externality - beneficial side effects, such as public education - can be corrected with subsidies externalities video

7-3: The Role of Government

Maintain competition

1. Prohibit market structures that are not competitive. - Antitrust legislation

2. Regulate markets when full competition is not possible.- See page 187 for a list of federal regulatory agencies and their

tasks.

Improve Economic Efficiency3. Promote transparency and require public disclosure4. Provide public goods, such as good roads and highways,

museums and libraries, and education. Modified Free Enterprise

Government intervention has created an economy based on markets with varying degrees of government regulation.